The EU on a Precarious Tightrope

After the relief of the recent election result in France, which saw political youngster Emmanuel Macron voted in as president, Europe braces itself for the German federal elections in September. Mark Devcich looks at the political movements that are worrying the financial markets.

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WINTER 2017

By Mark Devcich, Pie Funds

After two unexpected election results last year – the Brexit referendum on European Union (EU) membership and Donald Trump winning the United States presidential race – the financial markets are bracing themselves for elections in Europe this year and the potential for unexpected outcomes.

The concern for the markets is that a groundswell of anti-immigration and anti-EU feeling could grow and sweep across Europe. Given the current fragility of the EU, if this movement gathers support in one country, it could create a domino effect, causing ructions further afield.

Europe goes to the polls

First, the Dutch parliamentary election in March went as expected and financial markets breathed a sigh of relief as the anti-establishment populist candidate Geert Wilders failed to gain enough support and the People's Party won again, by a decisive margin.

Now, the markets are relieved about an even more important election result – far-right lawyer Marine Le Pen failed to win the French presidential election.

And at the time of writing, the result of the UK general election on 8 June is unknown. Incumbent prime minister Theresa May called an early election to gain a stronger political mandate ahead of Brexit negotiations and take advantage of the disarray her opponents, especially the Labour Party, are experiencing.

However, the most important vote in Europe this year is still to come – the German federal election on 24 September. For the financial markets, it’s crucial that the new ruling coalition is supportive of the EU. The alternative may lead to extreme uncertainty and a potential dismantling of the EU, especially if a key member such as Germany were to change its position on Europe.

If Le Pen had won in France, the EU would have been in crisis mode as her party, the Front National, is far right, anti-EU and was looking to make France more protectionist.

Historic French election

Instead it was a landslide victory for centrist, and former economy minister and investment banker Emmanuel Macron, who ran as an independent. Macron won the first round of voting on 23 April with 24 per cent of votes, ahead of Le Pen, who took 22 per cent. In the second round on 7 May, when it was down to just the two leading candidates, Macron won by a landslide 65 per cent to Le Pen’s 35 per cent.

Macron was an interesting candidate, much for his relative youth, which at the age of 39 makes him France’s youngest president. But he also attracted a lot of headlines because of his wife, who is 25 years older than him.

Macron has liberal economic inclinations, but is left-leaning socially. He campaigned on cutting public spending and taxes, relaxing labour laws, and reforming the unemployment system.

What made the race more intriguing was that it was the first time in many years that the traditional left and right parties both failed to progress beyond the first round of voting.

The other feature of the French elections was the relative accuracy of the polls leading into the elections, especially compared to the Brexit referendum and the US elections. This meant there were likely to be fewer surprises that could upset financial markets.

The polls had Macron as the clear favourite to win the second round of voting, and that prediction turned out to be spot on. This accuracy may be explained by typically higher voter participation in France, which means fewer hidden voters, although the turnout this time was one of the lowest for many elections.

The single national vote is also easier to model than results of the 650 individual elections for the UK Parliament or the 50 state contests that decide the US presidency.

All eyes on Germany

Chancellor Angela Merkel, Europe’s most powerful politician, still commands about 35 per cent support within Germany. However, like the incumbent People’s Party in the Netherlands, Merkel’s centre-right Christian Democrats will be under strong attack from far-right populist movements, such as the Alternative for Germany (AFD) party, which was formed in 2013.

Any result that saw Merkel toppled would send shockwaves through Europe. However, the initial polling suggests that Merkel has a strong lead over the challenging parties, with the AFD polling between10 and 15 per cent. Her main rivals, the German Social Democrats (SPD), have seen their popularity fall below 30 per cent, in comparison.

Merkel’s position is stronger than the polling suggests, especially as the AFD would struggle to form a coalition with other parties, even if it took a substantial portion of the vote.

Support for populism

The rise of populism is great for newspaper headlines. But in reality it is difficult to see the extreme far-right parties holding the balance of power in Germany. This situation is likely to placate the markets until they find the next reason to worry.

Longer term though, the composition of the EU seems to be more difficult to justify in its current state, because of the vastly differing outcomes for its members.

The countries that are seeing the most advantage from the EU seem to be larger, richer ones, such as Germany, because they benefit from a weakened currency and a cheap supply of labour.

When elections come around in the EU’s less-wealthy member countries, they may unveil more populist support for an anti-EU agenda than is being found in France and Germany.